A Lower Mortgage Rate Might Be Too Good to Be True. Here’s Why – The Motley Fool

It could come at a different cost. 

It’s gotten expensive to take out a mortgage loan. That’s because mortgage rates are considerably higher than they were a year ago. And home prices are also elevated. In November, the median existing-home sales price rose to $370,700, reports the National Association of Realtors. That’s a 3.5% jump from a year prior.

All told, buyers need to be very careful when purchasing a home and signing a loan to finance one. And so now more so than ever, it’s essential to shop around for a mortgage rather than jump on the first offer that comes your way.

But in the course of your mortgage shopping, you may be inclined to go with the loan that comes with the lowest interest rate. That logic certainly makes sense. But there may be more to the story than the rate you’re looking at. And in some cases, a lower mortgage rate might actually cost you in other ways.

When a lower mortgage rate doesn’t mean you’re saving money

It may be that one lender is able to offer you a lower rate on a mortgage than another. But what closing costs are you looking at in return? If those fees are high, then it may be that they’ll wipe out the savings you’ll get via a lower rate. 

Let’s say you’re offered a 30-year, $300,000 mortgage at 6.5%. That leaves you with a monthly principal and interest payment of $1,897. If another lender offers you a rate of 6.4%, you might think it’s an easy call to take it. At that point, your monthly payment drops to $1,876.

But what if that first lender with the 6.5% rate wants to charge you $6,000 in closing costs and the second lender wants to charge you $9,000? That second loan might save you $21 on your monthly mortgage payments. But if you’re looking at an extra $3,000 in closing costs, it will take you about 143 months, or almost 12 years, to break even. And who knows if you’ll even still be in your home by then?

In addition to higher closing costs, a lower mortgage rate might also come with the requirement to pay points. Some lenders will let you buy down your rate with points, and in some cases, it makes sense. But it will also cost you.

One point on a mortgage is equal to 1% of the sum you’re borrowing. So in our example of a $300,000 mortgage, one point would cost you $3,000. By paying that $3,000, you might manage to lower your mortgage rate by 0.25%. 

So, let’s say you can drop a 6.5% mortgage rate to 6.25% by paying for a point. That leaves you with a monthly payment of $1,848. That’s $49 in monthly savings compared to a mortgage rate of 6.5%. But when you factor in the $3,000 you’re spending, it will take you 61 months, or over five years, to break even. That’s still a long time.

Read the fine print

A lower interest rate on your mortgage could save you money. But make sure you’re not taking on added costs in the process. If so, that lower rate may not be worth it.